This auction is two weeks away, so I thought I’d take a preliminary peek at it. This will be a reissue of CUSIP 912828UX6, which first auctioned on April 18 with a yield to maturity of -1.311%. This 4-year, 8-month reissue will carry the existing coupon rate of 0.125%.
If you liked it in April … Obviously, a lot has happened since April, with TIPS yields rising dramatically for two reasons: 1) the Federal Reserve’s announced plan to begin tapering its Treasury-buying program if the economy continues improving, and 2) a trend of sluggish U.S. inflation, which makes TIPS less attractive to investors.
Here’s a recap of 5-year TIPS yields in 2013, demonstrating that even as nominal Treasury rates rose, and even after a recent decline in TIPS yields, TIPS have become less expensive compared to a traditional Treasury:
| Date | 5-year TIPS | 5-year Treasury | Inflation Breakeven |
| 2-Jan-13 | -1.36 | 0.76 | 2.12 |
| 1-Feb-13 | -1.46 | 0.88 | 2.34 |
| 1-Mar-13 | -1.45 | 0.75 | 2.20 |
| 1-Apr-13 | -1.47 | 0.76 | 2.23 |
| 1-May-13 | -1.33 | 0.65 | 1.98 |
| 3-Jun-13 | -0.86 | 1.03 | 1.89 |
| 1-Jul-13 | -0.41 | 1.39 | 1.80 |
| 1-Aug-13 | -0.45 | 1.49 | 1.94 |
| 7-Aug-13 | -0.55 | 1.38 | 1.93 |
Although you see negative yields in this list for the TIPS, that negative rate is offset by inflation. The base principal of a TIPS increases with inflation until maturity. That is why the breakeven rate is so important. Right now, a 5-year TIPS will outperform a 5-year Treasury if inflation averages more than 1.93% over the next 5 years.
Inflation over the last five years has averaged 1.3%, but that was only the second time it has been under 2.0% in a five-year period in the last 50 years. See a chart.
As of Wednesday, CUSIP 912828UX6 was trading on the secondary market at -0.670%, a little worse than the Treasury estimate listed above for a full 5-year TIPS.
Because it carries a coupon rate of 0.125%, buyers will be ‘paying up’ to get the resulting negative yield. My guess currently is about $10,325 for $10,000 of value, down from about $10,782 when the TIPS was first auctioned.
Danger in paying up. While your principal is guaranteed at maturity, the amount you pay up is not guaranteed. If we see 5 years of deflation, a buyer paying $10,325 this month will get $10,000 back at maturity, along with earning 01.25%. I consider this highly unlikely, but it is worth noting.
Alternatives? There is no doubt that the US Savings I Bond is superior to a 5-year TIPS. It pays the rate of inflation, minus nothing, has rock-solid deflation protection and is tax-deferred until maturity, which can be anywhere (without penalty) from 5 years to 30 years. The hitch is that you can buy only $10,000 per person per year. (You can also get additional paper I Bonds in lieu of income tax refund.)
What about insured bank CDs? My local credit union is paying 1.30% on 5-year CD, less than a 5-year Treasury. You can shop around and find better rates, possibly up to 2.0%, which would push the breakeven rate up to 2.55%. A bank CD with a high rate is pretty competitive, if you can find those ‘lofty’ rates.
Trend is working against buyers. The 5-year TIPS yield has dropped 10 basis points since Aug. 1, and 28 basis points since July 5. It’s a trend worth watching. While I would like to add this TIPS to my bond ladder, I am going to keep an eye on that yield.
A lot can happen in two weeks.
Treasury Inflation-Protected Securities 
Pingback: TIPS watchers ask: What exactly did the Federal Reserve minutes say? | Treasury Inflation-Protected Securities
Pingback: U.S. inflation ran a moderate 0.2% in July | Treasury Inflation-Protected Securities
I think with TIPS, you just have to watch the real rates and just figure out how many years you want to go out. The longer you go out the more short term risk you are taking. I would not buy the 5 year TIPS as the breakeven inflation rate is not that great compared to an I bond or a 5 year CD.
Jimbo, a couple of thoughts:
1) I suspect that when the GDP growth rises above 2%, TIPS yields will rise in lockstep. So if GDP can get to 3%, TIPS yields (10-year) will be 1% or higher.
2) On the latest run-up in TIPS yield, yes, we are at a stalling point, but yields definitely could rise from here. That seems to be the most likely result, unless the economy tanks. This 5-year has gone from very mildly attractive to sort of unattractive, all in a few weeks. My leaning right now is to ‘keep my powder dry’ as you say.
Back in early July, I had high hopes that the upcoming 5 year TIPS auction in August would actually come in with a positive YTM. As your chart shows, the yields went from -.86 in early June to -41 in early July. If that trend had continued, it would have gone positive by early August.
Right now, the financial goals that I have for TIPS are very modest. Basically anything that has a positive YTM does it for me. At the current moment, all that I want TIPS to do is preserve the purchasing power of the bond. If you buy at or below par, that’s pretty much a given.
In order to breakeven against inflation with a CD, I have to go out to terms of approximately five years. Before the financial crisis, I could simply purchase a three or six month CD to breakeven with inflation. I could consistently beat inflation buying CD’s with terms greater than a year.
Ideally, we’d get back to a normal coupon on TIPS in my lifetime. If I could get 2% plus inflation, I’d never run out of money in retirement. The question is – how long is it going to take to get there? It took about five years for TIPS yields to bottom-out. How long will it take for them to recover?
This latest run-up in yields seems to be over. This week has seen a steady erosion of TIPS yields. So, I’ll keep my powder dry and wait for the next buying opportunity. I’m kind of hoping that will be in September after Bernanke’s last speech. For now, I think that I’ll pass on the 5 year auction.